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5/6 ARM: 5/6 Adjustable Rate Mortgage in Home Loans

What is a 5/6 Adjustable Rate Mortgage?

A 5/6 ARM is a kind of hybrid adjustable-rate mortgage in which the fixed interest rate period of the mortgage lasts for 5 years. After the fixed-rate period is over, the variable-interest rate part of the mortgage begins.

What’s the difference between a 5/1 ARM and a 5/6 ARM?

In a 5/1 ARM, after the 5-year fixed-rate period, the interest rates are adjusted once a year based on a market index. In a 5/6 ARM, after the 5-year fixed-rate period, the interest rates are adjusted once every 6 months. That can be great if interest rates are falling -- but it interest rates are rising, it can seriously increase your monthly mortgage payments (and cause you a big headache).

What are the risks of a 5/6 ARM?

With a 5/6 ARM, your interest rate could go up every six months after the first five years of your loan, a pretty big risk in itself. So, unless you can predict the future (we’re still trying), you should make sure that you can handle the maximum potential monthly payment you could be charged, or be willing to sell or refinance your home once the fixed period of your mortgage is over.

Despite those risks, if you have 5/6 ARM, your interest rates won’t increase indefinitely. Just like other ARMs, 5/6 ARMs have both lifetime caps and periodic caps. Lifetime caps limit the maximum amount that the interest rate can increase from the initial rate. For example, a 3% loan with a 2% maximum cap would never go beyond 5%.

In comparison, periodic caps limit the amount that your interest rate can increase during each adjustment period. So, if your 5/6 ARM’s 5-year fixed rate period is up and you have a 0.5% periodic cap (started with the same 3% interest rate) your payment couldn’t go up to more than 3.5% in the first 6-month period.

How are the variable interest rates for a 5/6 ARM calculated?

Just like other ARMs, the variable interest rates for a 5/6 ARM are calculated based on a market index -- a rate that reflects the amount of interest banks charge when they loan each other money. In addition to the market index rate, banks charge a margin, which is an additional amount that covers their profit and reduces their risk. Depending on your credit score, your downpayment, and the amount you want to borrow, you might be able to negotiate your specific margin with your lender.

Many ARMs are based on the LIBOR (London Interbank Offered Rate) or the Constant Maturity Treasury (CMT) indexes. In the coming years, though, some think that the LIBOR rate should be phased out, due to the fact that, in 2012, an international investigation discovered that several major banks had been manipulating the LIBOR rate since as early as 2003. Even though the scandal finished several years ago, the ripples could still start affecting people with 7/1, 7/6 or 10/1 ARMs, who have just started (or are about to start) the adjustable interest rate period of their mortgage.

Another market index, called the MTA (Moving Treasury Index), is also sometimes used to calculate 5/6 ARMs -- and, due to the fact that it lags behind other indexes, it could help borrowers keep rates down during times when interest rates are going up.

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